Thursday, February 20, 2014

New Media Investment Group Spinoff

New Media Investment Group (NYSE: NEWM) is a recent local newspaper/media spinoff of Newcastle Investment Corp (NYSE: NCT). It was formed as a result of Fortress/Newcastle's ownership in GateHouse Media debt prior to a prepackaged bankruptcy and their purchase of Dow Jones Local Media Group from News Corp in September 2013. For me it hits several themes that I like, (1) it's an unwanted spinoff from an investor base that's likely to sell it off, (2) it operates in an out of a favor industry, and (3) it is run by a capital allocation expert (although at a cost).

Local Newspapers

Berkshire Hathaway's Warren Buffett recently purchased 28 local newspapers for $344 million dollars. It's a very small purchase for a $270B+ Berkshire Hathaway, and Warren has a soft spot for newspapers, but he still wouldn't make the purchase if it didn't make economic sense. The industry has value. Local newspapers have a connection to small communities who rely on their hometown newspapers for updates on local schools, sports teams, community politics, and local advertising that's hard to replicate for free.

Most people also assume that newspapers are in permanent decline, but I think it's a wrong assumption that the move to digital will permanently lower the revenue and profitability of the newspaper industry. Owners of businesses demand a certain return on investment, and businesses are fairly organic, it may take time, but eventual newspapers will restructure, consolidate, and earn a respectable ROI.

Deal History
Prior to GateHouse Media's bankruptcy, the company had a total of $1.2 billion face amount of debt, majority of which was owned by Fortress/Newcastle. GateHouse Media went into the credit crisis overleveraged and ran into trouble, Newcastle (externally managed by Fortress) grouped together with other debt holders and restructured the company this past November. Newcastle basically dual tracked the purchase of Dow Jones Local Media Group from News Corp (another spinoff and one of my holdings) in September, together with GateHouse Media, to form a new local news media company. Since Newcastle is a REIT, it makes little sense to hold a non real estate operating company like New Media within the restrictive REIT structure, so they decide to spin out the media assets into a new entity.

Post Spinoff
After the spinoff, New Media will have 435 community newspapers, related mobile sites, and 6 yellow page directories. That appears to be just the start, as Fortress has identified nearly $1 billion in potential acquisitions they believe can be purchased at between 2x-5x EBITDA, and then presumably integrated with GateHouse/Local Media, costs cut, resulting in increasing operating leverage. There is a track record here, as Newcastle/Fortress was able to buy Local Media from News Corp at roughly 3.4x EBITDA (after backing out the real estate value). By doing this, Fortress projects they can earn 20-25% unleveraged returns, and 30-35% return on equity with leverage. New Media will also get attention from investors as it plans to pay out a significant portion of their cash flow in the form of a dividend.

Investors post spinoff might get the chance at a better return as the price is likely to decline in the near term due to uneconomic sellers for the following reasons:

New Media is unrelated to Newcastle's core business (senior housing REIT, and some legacy CDO debt), there's probably not a lot of shareholder overlap other than those who are loyal to Fortress Investment Group.

Newspapers and yellow page directories are an out of favor business that are unpopular and unsexy to discuss at cocktail parties.

Unfortunately, I thought there might be more index fund selling due to New Media not being a REIT, but as Newcastle is transitioning from a mortgage REIT to an equity REIT structure, it's not included in the MSCI US REIT Index. But there still might be some REIT focused holders that will be forced to sell New Media in the coming weeks.

Valuation
While revenues have been stabilizing, they're still falling, New Media hopes to reverse the trend with their digital advertising business Propel. I would encourage people to check out their slides on Propel in their recent presentations, but I don't put much value in it.

As for a current EV/EBITDA multiple, below are the actual/projected numbers for the two newspaper companies forming New Media, as reported in their initial investor presentation in the fall.

If you combine the two 2013 numbers, you come up with $105 million in EBITDA. New Media has 30,000,000 shares outstanding, based on today's closing price of $12.20 you get a market capitalization of $366 million. New Media took on $185 million in debt after the GateHouse restructuring and the purchase of Local Media Group, making an enterprise value of $551 million, and an EV/EBITDA multiple of a little over 5.2x, definitely cheap, but on the high end of what Fortress thinks they can pay for acquisitions in the industry. I'd like to pay to a little below 5x and that's before the issue of the external management expenses.

External Management
New Media will be externally managed by Fortress Investment Group, a large private equity/alternative investment manager with little direct expertise with media companies. Fortress is handsomely paid for this arrangement; it receives 1.5% of equity annually and 25% of adjusted profits (adding back depreciation and amortization, among other adjustments) above a 10% hurdle, so you're essentially investing in a cheap media company with a private equity fee wrapper. The advantage of having a private equity fund manage an operating business is the capital allocation, Fortress says they have identified up to $1 billion in potential acquisition targets in the near term, which would almost quadruple the size of the company (and presumably add operating leverage along the way).

But external managers have their downsides, (1) the management fee is based on assets which essentially incentivizes them to increase the asset base irrespective of the price they pay for the assets, and (2) the incentive fee may cause the manager to take unnecessary risks as their payoff is skewed to the upside and they don't participate equally in the downside.

The benefit usually touted for externally managed REITs is the manager has greater scale and charges the REIT less than what they'd pay internal management. But unlike other externally managed REITs which have limited staff that work directly for the company, New Media has its own operational management team, including a separate CEO, so I'm a little cautious on how this type of model will work in a non-REIT entity. Will the additional costs outweigh the cheapness?

Another question I have is around the potential incentive alignments with an acquisition, to me New Media would best be run as a short term vehicle that would later be acquired by a true private equity investor or a larger media company. But its unclear to me how that would benefit Fortress and if they'd really go for it? Yes, they have a decent size equity position, but the fees they earn from keeping New Media as a separate entity far outweigh any premium they would get for their equity in a buyout scenario.

Conclusion
New Media has a lot of attributes that I like in a potential investment, but I'm holding off for now to see if it will get cheaper and I'm still trying to get my arms around what discount it should have with an external manager. I'd appreciate any thoughts or comments on New Media, especially around the external manager arrangement, feel free to leave a comment below or email me at clarkstreetvalue@gmail.com.

I have another 2-3 ideas that I'll post over the next few weeks, and will probably buy my favorite 1-2 of those.

(I'm not 100% positive on some of the numbers above as the financials are still settling, please do your own research)

There are a couple reasons for the use of EBITDA here: (1) There are no GAAP earnings, (2) Fortress hasn't clearly laid out the amount of normalized debt they plan on putting on the business, it appears like its going to increase and they've generalized the plan to lever it up 2x, so EV/EBITDA does an okay job of cancelling out some of the capital structure differences, and (3) while this sector may have previously had a lot of capex, Fortress is going to suck as much cash flow out as possible, I don't see them reinvesting much into the business, the plan is to treat this very much like an LBO. The goal is to acquire, cut costs, integrate, repeat.

Thanks for the article.Informative and with clear instruction for new. Only a few people look at the risk or benefit. Few don't know anything about the fundamentals of the company they invest in. Many don't look for dangerous upcoming issues or problem too. So hope it will help them to understand.

I don't think much has changed since I wrote this post, their results are a little lower than the previous year, TTM EBITDA is around $90MM, the only analyst covering the company pegs 2015 EBITDA at $115MM, so things still need to shake out a bit but the valuation is somewhere in the 5-7x EBITDA range. Cheap but I still have reservations about the management fee. Buying New Media is something like investing in a publicly traded private equity distressed investment fund, I see investors doing well in it, but I see Fortress doing even better. It's still near the top of my watchlist (I don't own any shares), just waiting for an even better price. Thanks for reading.